Bank of Japan: cupboard is bare but corporate prospects undimmed

After the Bank of Japan's latest policy decision, we look at the options left for authorities to stimulate the economy and the outlook for corporate earnings.

29/07/2016

Keith Wade

Chief Economist & Strategist

Shogo Maeda

Head of Japanese Equities

The economic view from Keith Wade, Chief Economist & Strategist

It is good to see a central bank acting independently, but today’s decision by the Bank of Japan (BoJ) to leave monetary policy broadly unchanged came as a major surprise.

The BoJ left interest rates and government bond purchases unchanged, at -0.1% and ¥80 trillion respectively. Expectations had been for an interest rate cut of at least 10 basis points (bps) and an increase in quantitative easing (QE) to ¥100 trillion.

The BoJ did increase its purchases of exchange traded funds (ETFs) to ¥6 trillion from ¥3.2 trillion, and has boosted the dollar lending support programme to $24 billion from $12 billion. The BoJ also announced a review of the effectiveness of monetary policy for its meeting scheduled for 20 and 21 September. However, these were minor details compared to expectations before the meeting.

Government preparing stimulus

One factor which helps explain the bank’s reluctance to act would be the large stimulus package being prepared by Prime Minister Shinzo Abe’s government. Earlier this week the government announced that this would total ¥28 trillion (over 5% GDP).

Today’s statement mentioned the synergies that would be produced by loose monetary policy alongside such a package, but it was not clear whether this meant the BoJ would be doing more or believed that its current policy stance is sufficient.

It is possible that the BoJ is simply waiting to see how much of the ¥28 trillion is “real money”; i.e. that it forms an increase in stimulus, before acting. Estimates range from ¥5 to ¥12 trillion, which at more than 2% of GDP would be substantial.

BoJ running out of options

However, as we have argued before, the BoJ cupboard is bare: QE is already running at full tilt and negative interest rates do not help the banking system in Japan. There is a reason why the government has turned to fiscal policy.

Of course the BoJ cannot admit this and Governor of the Bank of Japan Haruhiko Kuroda will emphasise his willingness to act at his press conference, but the foreign exchange markets are on the case and the Japanese yen has rallied significantly since the meeting.

The market view from Shogo Maeda, Head of Japanese Equities

Today, as was widely expected, the BoJ took action. Recently, Prime Minister Abe had indicated that a larger-than-expected ¥28 trillion economic package would be implemented in the coming years. Given such developments in both fiscal and monetary policy, we believe it is timely to revisit the investment opportunities that Japanese stocks offer.

More changes ahead

Firstly, the BoJ has announced additional easing including the doubling of both ETF purchases (to ¥6 trillion annually) and the US dollar lending program for overseas business expansion (to $24 billion). Notably there has been no further widening of the negative interest rate, which has disappointed some in the foreign exchange and Japanese government bond markets. At the same time, the BoJ appears to be sending a signal to investors that its next meeting may see changes in their measures.

While details will follow soon in terms of Abe’s economic package, both the government and the central bank are delivering pretty much what has been expected by the market. This should be modestly positive for the market as well as for the economy.

The BoJ’s decision to not widen the negative interest rate, which is positive for banks, insurance companies and for the market as a whole in our view, probably reflects the market’s concern over the negative impact the policy has had on pension fund liabilities and the financial sector.

Furthermore, both the BoJ and the government are succeeding, to some extent, in giving the impression that they are actively coordinating their efforts to improve the economy.

Corporate earnings could surprise positively

Meanwhile, in the Japanese stockmarket, which finished the month of June with a +6% return (TOPIX total return in yen terms), we see corporate earnings progressing reasonably well. Earnings for the first quarter (April to June) of fiscal year 2016 are coming out and, on the whole, they are exceeding market expectations. Excluding the currency impact, corporate earnings remain firm and we can expect positive surprises to consensus going forward.

Many Japanese companies are keeping a relatively tight control on costs and we believe dividends can be maintained even if earnings growth is revised down.

Changing attitudes

Looking ahead, we also expect greater investor engagement with companies, while changing attitudes among management will continue to encourage higher dividend pay-outs and share buy-backs. This can only have a positive impact and will further reinforce the focus on return-on-equity.

Indeed, we believe the Japanese market has largely discounted the potential negative impact of the stronger yen on earnings but sentiment remains highly sensitive to the yen/dollar exchange rate. Therefore, we think there is room for expansion of the current price-earnings* (P/E) multiple of around 13 times the current fiscal year earnings.

*A ratio used to value a company's shares. It is calculated by dividing the current market price by the earnings per share.

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